Josef G. Knoll-Europäischer ... - Stiftung Fiat Panis

Josef G. Knoll-Europäischer Wissenschaftspreisträger 2008
Josef G. Knoll-European-Science Award Winner 2008
Dr. Meike Wollni “Coping with the Coffee Crisis. An Analysis of the Production and
Marketing Performance of Coffee Farmers in Costa Rica”, University of Göttingen, 2007
Summary
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Problem setting
Changing patterns in global coffee markets led to a plunge in coffee prices that marked the
coffee crisis at the turn of the millennium. As a result of considerable oversupply of green
coffee on the international market, world coffee prices dropped to their lowest levels in 30 years
giving rise to one of the most severe crises experienced by the coffee sector to date. From a
macroeconomic perspective, the crisis had detrimental effects on export revenues and
employment in coffee producing countries. Negative consequences were especially felt in rural
areas, where the coffee sector is one of the most important employers and income alternatives
are often scarce. In many cases, coffee prices fell below the cost of production causing
widespread financial and social hardships among producers. All over the world, coffee
producing families were adversely affected by the depressed coffee prices resulting in negative
consequences for income and food security, children's school enrolment, and fanners' ability to
repay production loans. Economic losses and the lack of viable alternatives forced many
farmers to abandon their coffee plantations and migrate to urban areas in search of employment.
Overall, the effects of the crisis pose serious threats to the prospects for sustainable rural
development.
Many experts claim that even if prices recover in the short term, the current crisis is likely to
recur unless a structural transformation of the sector addresses the imbalance of supply and
demand. In this context, the potential role of differentiated markets in restoring the economic
viability of coffee cultivation has been highlighted. While coffee marketing has historically been
organized through a commodity-based system, in which the lowest cost production of a
standardized product is typically rewarded, a growing number of specialty marketing channels
have emerged in recent years satisfying increasingly diverse consumer demand patterns. As
opposed to conventional coffee, specialty coffee commands considerable price premiums in
international markets, potentially offering farmers a sustainable livelihood strategy and a way to
cope with the crisis. Compared to other coffee producing countries, Costa Rica's competitive
advantage is in the production of high-quality coffee, given its excellent growing conditions. In
light of the crisis, the country has put emphasis on exploring this competitive advantage trying
to motivate farmers to adjust their production to the requirements of specialty markets.
However, whether farmers can meet the standards required in these segments, and whether
higher prices are actually passed on to them, still remains an open empirical question. In this
context, the importance of marketing cooperatives has been highlighted as a link between
consumers and producers, which can potentially allow farmers to gain access to specialty
markets.

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Objectives
The main objective of this study is to analyze the effects of the coffee crisis on the Costa Rican
coffee sector, particularly on producers, and to identify the factors that influence production and
marketing performance of coffee farmers. Based on the analysis, policy recommendations are
derived that should help farmers to improve their competitiveness and their ability to cope with
the crisis. The overall aim can be broken down into several specific objectives addressed by this
research:
- To analyze the organization, coordination and performance of the Costa Rican coffee
sector with special regard to the changes that have been induced by the coffee crisis;
- To describe the coffee production and marketing activity of farmers in Costa Rica,
as well as their adaptation to the changing situation in world coffee markets;
- To analyze the factors that influence farmers' participation in specialty markets and
marketing cooperatives and the effect of participation on producer prices;
- To identify the factors that explain farm-level technical efficiency of coffee farmers
producing in the conventional and in the specialty segment, respectively; and
- To derive policy recommendations on how to improve fanners' performance in
coffee production and marketing in order to help them cope with the crisis.
Methodology
Conceptual framework
Given the adverse economic conditions caused by the coffee crisis, the economic performance
of coffee fanners is the key to improving the competitiveness of the sector and enabling farmers
to make a decent living. In general, economic growth can be achieved through (1) cost
reductions in the production of commodities, (2) technological innovations, and (3) the
introduction of new products and quality improvements. The scope of technological innovations
in coffee production is limited, especially as they cannot be achieved in the short run and are not
directly under the control of farmers. Therefore, this study concentrates mainly on points (1)
and (3) and their potential for offering fanners opportunities to enhance their competitiveness
and cope with the crisis. A conceptual framework is developed to guide the analysis of farmers'
production and marketing performance. Production performance is measured in terms of the
technical efficiency achieved in coffee production. Technical efficiency reflects the farmer's
ability to produce maximum output with a given level of inputs and given the available
technologies. As inefficiency in production results in a failure to maximize profits at the farm
level, increases in productive efficiency are expected to enhance farmers' competitiveness and
ability to confront the adverse economic conditions. Although technical efficiency is critical for
maximizing farm profits, it is not likely to provide high-cost producers, such as fanners in Costa
Rica, with a competitive advantage in international markets. Due to favorable natural conditions
for the production of high-quality coffee, their competitive position is more likely to be related
to product differentiation, which is more difficult to match by low-cost producers. Product
differentiation is based on the consumers' willingness to pay price premiums for the added
value of specialty coffee. Specialty coffees are distinguished by those that emphasize quality

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aspects (such as gourmet and estate coffees) and those that are produced under a specific
production technology (such as organic, shade-grown and fair trade coffees). Coffee marketed
through specialty channels is subject to various grades and standards aiming to ensure different
aspects of sustainability and product quality. If farmers wish to access specialty markets, they
have to comply with these standards often requiring the adoption of sustainable and qualityenhancing
production technologies. While considerable price premiums are paid by consumers
for the quality and process attributes of specialty coffee, it is not clear to what extent prices are
passed on to producers. Marketing performance is thus defined as the average price received by
farmers, which is in part determined by the farmer's choice of a marketing channel.
Furthermore, the conceptual framework explicitly discusses the potential role of cooperatives to
enhance farmers' access to specialty markets and productive resources potentially improving
their marketing and production performance.
Econometric estimation
Marketing performance of Costa Rican coffee farmers is modeled by means of an econometric
two-step model. The first stage of the model reflects the marketing decision of farmers. Two
separate binary choice models are estimated to identify the determinants of participation in
specialty and cooperative channels. In the second step, the average coffee prices received by
farmers are regressed on the marketing decisions and a range of other exogenous variables. The
fact that fanners are likely to select the marketing channel based on the expected price in the
available channels introduces a potential endogeneity bias. To control for this potential bias,
predictions for participation in specialty and cooperative channels are obtained from the firststage
probit models and are inserted on the right-hand-side of the price model instead of the
original variables. Results of the two-step model are compared to coefficient estimates obtained
from a three-stage least square model. In this approach, the marketing decisions and their effect
on prices are estimated simultaneously. Results obtained from the two different models are very
similar. The first method is, however, preferred as it explicitly accounts for the binary structure
of the marketing choices.
In order to analyze farmers' production performance, a stochastic frontier model is estimated
and the effects of a range of farm-specific variables on technical efficiency are determined
simultaneously. When estimating a production frontier, the underlying assumption is that all
farmers in the sample use the same production technology. In this study, some of the farmers
produce for specialty markets, which require the adoption of quality-enhancing production
techniques. To account for technological heterogeneity between sub-samples of farmers,
separate production frontiers are estimated for farmers cultivating conventional and specialty
coffee, respectively. However, the two sub-samples are unlikely to constitute unbiased
representations of the population. If farmers choose to participate in one group or the other
based on their expected performance under the chosen technology, the two sub-samples will
systematically differ with respect to certain farm and household characteristics. If self-selection
is ignored in the estimation of separate production frontiers, coefficient estimates will be
inconsistent. This study adds to the existent literature on farm-level efficiency analysis by
combining stochastic frontier methods with sample selection modelling techniques. Following
Heckman (1979) and Lee (1978), an inverse Mill's ratio is included in the frontier models to
control for self-selection bias.

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Empirical data
The study was carried out in the Western Valley and in the Brunca region representing two
major coffee regions in Costa Rica. A multi-stage cluster sampling was used to randomly select
216 households in 26 villages for the survey. A standardized questionnaire was administered to
households to collect data on coffee production, marketing, and prices as well as on the socioeconomic
characteristics of households covering the two-year period 2002 and 2003.
Results
Sub-sector study
The sub-sector study of the Costa Rican coffee sector reveals that besides having favorable
natural conditions for the production of high-quality coffee, Costa Rica also benefits from a
strong organizational structure throughout the production and marketing stages of the coffee
sector. The sector is regulated by the Institute of Coffee (ICAFE), which coordinates the
interactions between coffee producers, processors, roasters and exporters. While there are large
numbers of coffee farmers, the downstream segments of the sector are more concentrated.
However, 40% of the coffee production is processed and in part exported by farmer-owned
coffee cooperatives offering producers the opportunity to vertically integrate and receive some
of the value added at the downstream stages of the value chain. As a response to the crisis, the
Institute of Coffee has launched various initiatives to give farmers incentives to adjust their
production to the requirements of specialty markets and thus to increase the quality of coffee
produced in the country. During recent years, the efforts to increase quality started to become
evident in increased amounts of specialty coffee exported and relatively constant price
differentials obtained for specialty coffee at the export level. However, there is some evidence
that greater differentiation in final coffee markets has led to increased price differentials in
international markets but is not reflected in producer prices. The performance of the sector
depends critically on the degree to which these price differentials are actually passed on to the
producers of high-quality coffee.
Descriptive analysis
The descriptive analysis indicates that coffee cultivation is of major importance for most
households in the sample, even though the majority of households have a diversified income
portfolio. As a response to the crisis, households reduced the amount of land, hired labor, and
purchased inputs used in coffee cultivation. As a consequence, total output as well as average
yields declined. As a result of lower coffee incomes, household expenditures were negatively
affected. The analysis shows that households significantly reduced their expenditures in all
categories including food, education, clothing, and housing. Expenditures related to social
events were most drastically reduced by the households in the sample as a response to the
crisis. In addition, the descriptive analysis reveals that coffee cooperatives play an important
role in the organization of coffee production and marketing. With respect to production
performance, average yields arc slightly higher for cooperative members as compared to nonmembers,
but the difference is not significant. In regard to marketing performance, the analysis
confirms the hypothesized link between cooperatives and participation in specialty markets. The
descriptive analysis further suggests that prices obtained by farmers producing in the specialty
segment are higher compared to farmers selling their coffee in conventional markets. Moreover,

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farmers participating in cooperatives receive higher prices compared to farmers that market
their coffee mainly through private marketing channels. Over the course of the crisis, price
differentials between specialty and conventional channels as well as between cooperative and
private outlets further increased.
Marketing performance
The econometric analysis of farmers' marketing performance shows that both participation in
specialty coffee channels and in cooperatives improve the price received by farmers. Marketing
through cooperatives increases the average price received by 5 cents/lb, and participation in
specialty markets by 9 cents/lb. Furthermore, access to information about world market prices
leads to an increase of 3 cents/lb in producer prices. Moreover, the first-stage probit analysis on
participation in specialty markets confirms the link between cooperatives and access to
differentiated markets. Membership in cooperatives increases the probability that a farmer
chooses to grow specialty coffee by 24%. In addition, if farmers have received extension with
respect to quality-enhancing production practices, their probability of participation in the
specialty segment increases by 33%. Similarly, farmer education and experience in coffee
cultivation are found to have significant and positive effects on participation. Finally, another
policy-relevant finding is that large-scale farmers are more likely to participate in specialty
markets indicating that small-scale farmers may face barriers that hinder their participation in
differentiated markets.
Production performance
With respect to the analysis of production performance, the inverse Mill's ratio is found to be
significant in both production frontier models indicating that selection bias is present. Average
output of specialty coffee farmers is larger than it would be if all fanners were cultivating
specialty coffee. In contrast, average output of conventional farmers is smaller than it would be
if all farmers were using that technology. The fact that the inverse Mill's ratio is significant in
both models emphasizes the importance of controlling for selection bias when estimating
separate production functions. The differences in the determinants of technical inefficiency
among conventional and specialty coffee fanners are influenced by both identical and divergent
factors. Among the former, the size of the family increases inefficiency, while additional nonagricultural
income activities decrease inefficiency for both types of farms. The efficiencyenhancing
effect of other income-generating activities is often associated with better access to
information and liquidity of farmers working off-farm. Among the divergent factors, farm size,
experience and bookkeeping are found to have a significant impact in the specialty coffee
model. While experience and bookkeeping decrease farm-level inefficiency, the positive sign of
farm size indicates that small-scale farmers are more efficient in the production of specialty
coffee. In the case of conventional coffee farmers, membership in cooperatives leads to higher
farm-level efficiency.
Conclusions and policy implications
In Costa Rica, market regulations have aimed at guaranteeing a fair distribution of coffee
incomes among all actors involved, but have also limited the development of new market
segments and the remuneration of higher quality coffee. However, this is likely to change under
the quality improvement program defined by the coffee sector. The results of this study suggest

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that implementation of new marketing channels in the segment of specialty coffees should be
fostered to give fanners the opportunity to participate in these new market developments and
increase the value of their produce. In some cases, price incentives may suffice to motivate
farmers to increase the quality of their coffee and participate in differentiated markets. In many
cases, farmers will need more support to adopt quality standards and to acquire the necessary
information.
When fostering the expansion of production for specialty segments, two issues need to be taken
into consideration by decision-makers. First, as the analysis has shown, smallholders are easily
excluded. The lack of access to information and liquidity are only two of the factors that may
prevent small-scale farmers from participation. However, product differentiation is an important
tool to stay competitive in international markets and to increase the value of the coffee. Product
differentiation has traditionally been in the realm of small-scale farming and the present study
has shown that higher efficiency levels are achieved on smaller farms that produce in the
specialty segments. This underscores the fact that small-scale farmers can successfully
participate in differentiated markets once they are able to overcome the constraints that prevent
their participation in the first place. The second issue that decision-makers need to consider is
the degree to which supply is meeting current demand. If the production in specialty segments
is expanded beyond the levels of effective demand, oversupply will lead to falling prices and a
replication of the crisis currently experienced in the conventional market.
Based on the empirical analysis, three promising fields of policy action are identified including
the provision of extension and information, the support of coffee cooperatives, and the
diversification of the rural economy. Coffee cooperatives can help farmers to improve their
production and marketing performance, as shown in this study. As small-scale farmers are
more likely to choose a cooperative as an outlet for their coffee, cooperatives can be an effective
means to target services specifically to this group of farmers. Furthermore, the creation of
alternative income opportunities in rural areas is important to ameliorate at least some of the
devastating effects of the crisis and bring coffee production back in line with demand. As viable
alternatives are often scarce in rural areas, market research and enterprise development
programs are needed to support farmers in then-efforts to diversify into other agricultural and
non-agricultural activities.
Lit.:
Heckman, J., 1979. Sample selection bias as a specification error. Econometrica, 47, 153-162
Lee, L., 1978. Unionism and wage rates: a simultaneous equations model with qualitative and
limited dependent variables. International Economic Review, 19 (2), 415-433
Meike Wollni: Coping with the Coffee Crisis. An Analysis of the Production and Marketing
Performance of Coffee Farmers in Costa Rica, Peter Lang Frankfurt, 2007, ISBN: 978-3-631-
56431-8